UPDATE, 2/14/2011: My personal investing philosophy has changed, and now
revolves around passive indexing. For more details, see [Fail-Safe
Investing](http://personalmba.com/review/fail-safe-investing/) by Harry
Browne.

The Personal MBA won’t just help you increase your effectiveness at
work… it can also help you manage your savings and investments.

One of the most interesting long-term applications of the Personal MBA
is personal investing: knowing how to evaluate the financial and
competitive position of a company well enough to notice when the market
is underpricing a company relative to its likely future prospects.
Investing is a way to profit directly from your knowledge of business,
and it provides a great deal of motivation for mastering accounting,
finance, and other traditionally difficult subjects. (It’s always easier
to gain competence in a subject when there’s a reason you really want to
understand it.)

Frankly, 95%
of people are much better off passively investing their savings in a
total market index fund vs. attempting to manage their money
actively. Successful active investment management (higher returns than
the total market over a given period of time) takes a great deal of
knowledge, patience, effort, and emotional mastery. If you don’t
approach investing in the spirit of learning and mastery, it’s easy to
get carried away and lose your shirt or give up in disgust before you’re
really able to put what you’ve learned into practice.

“The market, like the Lord, helps those who help themselves. But,
unlike the Lord, the market does not forgive those who know not what
they do."

If you do know what you’re doing, however, developing an investment
strategy and learning how to actively manage your money can be both
personally and monetarily rewarding. In the past year, my returns have
been roughly 25% (vs. 14% for the
S&P 500 ), and I
have learned a ton about business along the way.

I’m currently an active member of the
Motley Fool discussion boards and
the American Association of Individual
Investors , both of which I’ve found enormously educational. At the
moment, I’m working with a small, dedicated team of experienced
investors to develop a systematic method of identifying promising small
companies that are selling at a large discount to what they’re worth.
There are no assignments or grades: we’re working on this together in
our spare time because we believe it will help us become better
investors.

Here’s my shot at developing a list of [due diligence] questions to
answer when either opening a small position or accumulating additional
shares in a company. My objective is to apply the Pareto Principle to
this list: I want to have a relatively short list of questions that can
be answered in no more than an hour or two that provides at least 80% of
what I need to know to make allocation decisions.

Before opening a small position…

Understanding the Company

Do I clearly understand how the company makes money?

Do I clearly understand what key factors drive the business?

Understanding the Current Valuation

What is the company’s current cash, debt, and profit margin situation?

What is my best estimate of the company’s reasonable value per share?

What is the worst case scenario? At what point does price = liquidation value?

Does the current price make sense? Is there a reasonable margin of safety at this price?

Understanding the Industry

How does this firm currently fit into the broader industry?

What is my best guess about how the industry will evolve over time?

What is the firm’s competitive advantage? Is that advantage durable, and does it line up with how the industry is evolving?

How does the company’s current cash, debt, and profit margin compare vs. competition?

Understanding Management

Does the company’s current management team appear to be experienced and competent?

Does management own the stock? Do they behave like manages or
owners?

When analyzing a position I already hold for potential accumulation, particularly if the price drops:

What’s changed?

What caused the price to change?

Has the business fundamentally changed since my initial analysis?

Have the fundamentals of the business (cash, debt, margin) eroded
significantly or unexpectedly?

Has management changed strategy or ownership behavior?

What is the prevailing market sentiment? Is it reasonable?

What’s the new valuation?

Based on what I now know, what is my best estimate of current value?

Does the current price make sense? Is there a reasonable margin of
safety at this price?

How should I allocate my capital?

Am I currently overweight in this company, with respect to my total
portfolio?

Is there a better opportunity for capital allocation elsewhere?

How much should I allocate to this company, based on this new
information?

My personal investing methodology has evolved over time, and I expect it
will continue to evolve as I learn more. The Personal MBA has been a
tremendous help in evaluating companies and has enabled me to create
this little list of questions: I know enough about how businesses work
that I can form an educated opinion of a company’s prospects relatively
quickly, which is a big benefit when potential opportunities present
themselves.

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